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Please note: The Frank Talk articles listed below contain historical material. The data provided was current at the time of publication. For current information regarding any of the funds mentioned in these presentations, please visit the appropriate fund performance page.

A Face-Off Between Passive and Active Investing

December 17, 2012

Exchange-traded funds continued to attract assets in 2012 while money has been exiting equity mutual funds. Still a majority of assets continue to be invested in actively managed products: As of the end of 2011, of the nearly $13 trillion invested in funds, index and exchange-traded funds comprise only about 8 percent, according to the Investment Company Institute.

As active investment managers who have experienced bull and bear markets, the financial industry’s deregulation and re-regulation, and the shifting needs of baby boomers, we are pleased that actively managed mutual funds continue to be the choice for a significant portion of portfolios.

The ETF industry has matured from its adolescent days, yet it continues to morph in puzzling ways that produce mediocre results. In my blog, I’ve discussed some eye-openers to help investors understand the risks of ETFs before putting their money in a product that might end up with unexpected outcomes.

Take the relatively new iShares MSCI Global Metals & Miners ETF (PICK), which began trading at the beginning of February 2012. The ETF is based on the MSCI ACWI Select Metals & Mining Producers Ex Gold & Silver Investable Market Index, which is a non-diversified basket of companies located in developed and emerging markets that are involved in producing or extracting metals or minerals. Its 10 largest holdings make up 50 percent of the index, which makes it a more concentrated, potentially more volatile, portfolio.

By comparison, as of November 30, 2012, the top 20 holdings in the Global Resources Fund (PSPFX) make up 43 percent of the overall portfolio.

In theory, one chooses a natural resources investment to gain access to the companies that stand to benefit from the world’s growing needs of natural resources. In addition, commodities offer portfolio diversification, as they have historically had a lower correlation to the overall market.

However, in a faceoff, PSPFX would steal the puck from PICK, as the Global Resources Fund has outperformed the ETF by nearly 13 percentage points since PICK’s inception in January 2012.

PSPFX also added significantly more return with less risk compared to the ETF over the same timeframe. The Global Resources Fund experienced an annualized standard deviation of 15.95 percent compared to the PICK ETF, which had an annualized standard deviation of 24.34 percent, according to Morningstar Direct.

You can also compare two gold equity investment vehicles. Although gold miners have had a challenging year, the Gold and Precious Metals Fund outperformed the Market Vectors Gold Miners ETF (GDX) by 400 basis points.

As I often remind investors during presentations, there is no free lunch on the commodities table—every investment comes at a cost or a risk. When it comes to emerging markets and commodities, there are inefficiencies that we believe give active managers an edge. In emerging markets, the capital markets are not as sophisticated as in developed markets and the information can be less uniform and straightforward. Managers who have an explicit and tacit knowledge of the country and its way of doing businesses are likely able to flush out the best opportunities. We believe it is worth paying a bit more in management fees to get the expertise needed for these specialized markets.

The Eastern European area is a good example of a nuanced market. While the presidential reelection of Vladimir Putin in Russia caused markets to stress over how he would lead the country, Turkish stocks have experienced substantial growth. U.S. Global Investors’ Eastern European Fund (EUROX) benefitted from its ability to invest in the entire area: Russian stocks make up only about 37 percent of the fund while Turkey comprises 17 percent of the fund. See the fund’s regional breakdown here.

We believe this is why we have significantly outperformed the Market Vectors Russia ETF year-to-date as of December 13, 2012:

Indexers often argue that active managers have periods of underperformance. Fellow Canadian Wayne Gretzky has been called the greatest hockey player ever, holding or sharing more than 60 records that he collected during his 20 seasons of playing in the National Hockey League. He holds the NHL record for the most hat tricks—achieving three goals in a single game more than 50 times—and when he retired, Gretzky was inducted into the Hockey Hall of Fame.

However, under asset management’s rigid standards for active managers, the “Great One” might be considered a loser, as his team won the Stanley Cup “only” four times.

From time to time, active managers underperform; yet, they have the opportunity to add alpha. ETFs, on the other hand, are built to only match the benchmark and are never expected to beat it.

While ETFs offer instant execution, liquidity and lower fees, certain passive investments may not get you where you want to go over the long-term. The “hat trick” equivalent that Global Resources, Gold and Precious Metals, and Eastern European Funds has been able to achieve this year against their respective ETF peers is more diversification, better historical performance and less volatility.

Outlook on Natural Resources
Learn what our investment team believes will drive gold and natural resources in the new year by joining our Outlook 2013 webcast. Sign up today and email us with your questions, so we make sure we cover what’s on your mind.

Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by clicking here or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Foreside Fund Services, LLC, Distributor. U.S. Global Investors is the investment adviser.

Read additional important information.

Bond funds are subject to interest-rate risk; their value declines as interest rates rise. Tax-exempt income is federal income tax free. A portion of this income may be subject to state and local income taxes, and if applicable, may subject certain investors to the Alternative Minimum Tax as well. The Near-Term Tax Free Fund may invest up to 20% of its assets in securities that pay taxable interest. Income or fund distributions attributable to capital gains are usually subject to both state and federal income taxes. The tax free funds may be exposed to risks related to a concentration of investments in a particular state or geographic area. These investments present risks resulting from changes in economic conditions of the region or issuer.

Gold, precious metals, and precious minerals funds may be susceptible to adverse economic, political or regulatory developments due to concentrating in a single theme. The prices of gold, precious metals, and precious minerals are subject to substantial price fluctuations over short periods of time and may be affected by unpredicted international monetary and political policies. We suggest investing no more than 5% to 10% of your portfolio in these sectors.

Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk. By investing in a specific geographic region, a regional fund’s returns and share price may be more volatile than those of a less concentrated portfolio.

The Emerging Europe Fund invests more than 25% of its investments in companies principally engaged in the oil & gas or banking industries. The risk of concentrating investments in this group of industries will make the fund more susceptible to risk in these industries than funds which do not concentrate their investments in an industry and may make the fund’s performance more volatile.

Because the Global Resources Fund concentrates its investments in a specific industry, the fund may be subject to greater risks and fluctuations than a portfolio representing a broader range of industries.

Stock markets can be volatile and share prices can fluctuate in response to sector-related and other risks as described in the fund prospectus.

Morningstar Ratings are based on risk-adjusted return. The Overall Morningstar Rating for a fund is derived from a weighted-average of the performance figures associated with its three-, five- and ten-year (if applicable) Morningstar Rating metrics. Past performance does not guarantee future results. For each fund with at least a three-year history, Morningstar calculates a Morningstar Rating? based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a fund’s monthly performance (including the effects of sales charges, loads, and redemption fees), placing more emphasis on downward variations and rewarding consistent performance. The top 10% of funds in each category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars and the bottom 10% receive 1 star. (Each share class is counted as a fraction of one fund within this scale and rated separately, which may cause slight variations in the distribution percentages.)

Each of the mutual funds or services referred to in the U.S. Global Investors, Inc. website may be offered only to persons in the United States. This website should not be considered a solicitation or offering of any investment product or service to investors residing outside the United States.

Certain materials on the site may contain dated information. The information provided was current at the time of publication. For current information regarding any of the funds mentioned in such materials, please visit the fund performance page.

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